White hot silver

Commentary: Using Newton’s first law of motion to spot winners

By

JohnNyaradi

BEND, Ore. (MarketWatch) — Newton’s first law of motion states that the velocity of a body remains constant unless the body is acted upon by an external force. In the arena of exchange-traded funds, sectors and ETFs with strong momentum can often continue on strong trajectories, and July’s “sector of the month” was silver, as the white metal has been white hot.

Precious metals, and silver, in particular, were the leading sector in July in response to the debt ceiling crisis and a “flight for safety” from a potential U.S. default.

Up some 18% for July and approximately 29% year to date, the white metal, sometimes referred to as “poor man’s gold,” has put in an impressive performance in spite of the precipitous decline it experienced earlier this spring.

While gold gets most of the press, it’s up “only” 14% so far for 2011, and so silver has really offered “margined” returns compared to a similar investment in gold.

Many factors have propelled silver on this upward trajectory including uncertainty over the deficit ceiling debate and the overall run up in commodity prices in response to the Federal Reserve’s quantitative easing policies.

Other fundamental factors are also at play like demand from China, which has become a net importer of silver, along with major institutions and hedge funds always looking for an accelerating momentum asset play.

Since it appears that the debt ceiling debate has been “resolved,” at least for this week, the immediate short term result will likely be a correction or at least short term retracement in the price of silver and other precious metals.

However, an even greater long term threat than the deficit ceiling soap opera is the potential downgrade of the U.S. AAA credit rating.

The likelihood of this happening as early as sometime in the next 90 days is quite high as the ratings agencies have been looking for a substantial commitment to deficit reduction and the “bond vigilantes” have been prowling the globe in search of weak sovereign powers.

Any downgrade of the U.S. credit rating would be a meteor strike to the heart of the financial system as many large investment funds are required to invest in only AAA rated investments.

Therefore, a U.S. credit rating downgrade could easily lead to a global sell off of U.S. Treasuries, and you don’t have to be an economist to figure out that this would be bearish for equities and the U.S. dollar and more than bullish for gold and silver.

Finally, many analysts suggest that the only possible outcome of quantitative easing is hyper-inflation. Should inflation take hold in earnest, it is always difficult to stop or even slow down, and this kind of environment would also be bullish for silver.

Several ETFs offer exposure to the silver market and are worthy of consideration in the days and months ahead.

The “900 pound gorilla” among silver ETFs is the iShares Silver Trust
SLV, -0.07%
which has the objective of reflecting the price of silver owned by the trust and is the largest exchange-traded fund focused on silver.

In the chart above, you can see how it is above both its 50- and 200-day moving averages and slowly declining from near overbought levels on relative strength, or RSI.

Another option is PowerShares DB Silver Fund
DBS, +0.08%
which is designed to track the performance of the Deutsche Bank Liquid Commodity Index - Optimum Yield Silver Excess Return and so seeks to reflect the price performance of silver by using silver future contracts.

A third ETF offering exposure to the silver sector is ETFS Physical Silver Shares
SIVR, -0.16%
which tracks the price of silver bullion and whose shares are backed by physical bullion held by a custodian.

So silver is likely due for a short-term correction as the world celebrates the United States avoiding a devastating default.

Silver bulls would say that any such correction would be a buying opportunity as Newton’s first law should stay in force in the world of silver ETFs. Over a longer time horizon, numerous fundamental and technical factors also point to the likelihood of silver, July’s “sector of the month,” staying white hot as we move farther down the road into the second half of 2011 and beyond.

John
Nyaradi

John Nyaradi publishes Wall Street Sector Selector (www.wallstreetsectorselector.com), which provides news, analysis and strategies for trading exchange-traded funds. He's also the author of "Super Sectors: How To Outsmart the Market Using Sector Rotation and ETFs."

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John
Nyaradi

John Nyaradi publishes Wall Street Sector Selector (www.wallstreetsectorselector.com), which provides news, analysis and strategies for trading exchange-traded funds. He's also the author of "Super Sectors: How To Outsmart the Market Using Sector Rotation and ETFs."

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